In this blog post, Manoj Kumar Das, an Assistant Manager in the Materials and Contracts, Indian Oil Corporation Limited, Refineries Division and a student pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, analyses and discusses on how to choose the right business structure. 

One of the first Things that comes to one’s mind when starting a business is: How to structure my business? This question shall pull up a plethora of variables into context. The owner has to weigh his options and pick up the right business structure. There is Liability, on one hand, Finances on the other and so on. Choosing the right business structure may often determine the difference between success and failure.

Here we come upon the four types of Legal structures that can be chosen:

• Proprietorship or Self-Proprietorship
• Partnership
• Limited Liability Partnership
• Company

Types Of Business Structures

Each structure has its own advantages and disadvantages. Depending upon his circumstances, a business owner shall decide upon the suitability of the structure. It may depend on his quantum of investment, taxation structure, amount of control & ownership the owner desires, the extent of liabilities and future financing options and so on.

In a sole proprietorship, the business is owned & controlled by a single person. All authority, responsibility and obligations of the business rest upon the sole owner. He gets all the profits, bears all the losses and is liable for all the debts incurred. The owner and the business are one entity. He owns all the assets & properties of the business. Hence it is suitable for a business which has a smaller size or limited investments or limited risks or smaller localised markets.

Also, it has other advantages as well. The legal formalities, setup costs and other administrative tangles are less. The business can be easily setup and the business strategy and function remains relatively confidential. Since the decisions are pivoted on a single person, they are taken much quicker, and this benefits the business. This flexibility also might add to the business’s success. The finances are controlled by a single entity, and this gives the owner a very strong stimulus to work. The owner can put effort to develop one on one relationship with his customers and can give personal attention to each one.

But on the flip side, one has to look at the cons too. All the debts are the liability of the owner. His properties & owned assets can be liquidated to fulfil the debt and obligations of the business. There can be a very high financial risk. Also, opportunities for raising capital for investments are very limited and same goes for the quantum of investment too. Not many investors will be willing to put their money on a business tied to decisions and control of a single entity. Loans or Investments from Friends & family are a general norm. For a business to succeed, it needs to have its own core competencies to surpass the competition. Hence, it is obvious for a business to acquire specialised talent or expertise in relevant fields, as it cannot be available in a single person. Also, hired expertise and skilled employees are costly to acquire and retain. This adds to the limitation of the proprietorship. Moreover, the limited scope of growth for employees in a small setup such as a proprietorship is also a turndown. The ownership & existence of the business is tied to a single person; further succession is an issue as the company ceases to exist after the death of the owner.

A partnership is a relationship between persons defined by an agreement to share the profits of a business carried on by the partners or any of them acting for all. The partners have unlimited liability. In contrast to a proprietorship different person with different skills, expertise and knowledge together form a partnership. This pooling of knowledge and decisions coupled with sharing of responsibilities and work gives an edge over proprietorship. Efficient distribution of work suited to each partner’s skill, expertise and interest can be achieved. In a partnership several partners contribute to the capital, hence financial resources are better. Also the losses, debts, liabilities and obligations are shared by the partners.

The confidentiality of decisions, strategy and functioning, is relatively weaker. The probability of disagreement or conflict of interest between partners is higher. This may lead to a quicker dissolution of the business than envisaged.

In a limited liability partnership (LLP) partners have limited liabilities. The limited liability partnership is a distinct legal or corporate entity separate from its partners, that is, it can acquire and hold property and execute a contract in its name. It creates a protective layer between a partner’s assets or properties and the business as each partner’s liability is limited to the extent of contribution towards the limited liability partnership. Liability of debt and obligations of the limited liability partnership lies on it and not on the partners. Also, a partner is not liable for the acts of other partners and thus is shielded from unauthorised or wrongful acts of another partner. Change in partners does not result in dissolution or termination of the business. It has lesser regulatory controls & compliances than that of a company’s. It is suitable for and small & medium sized business.

But the extent of opportunities for raising capital investment is still very less compared to a company.

A company is a legal entity that is created to conduct business, and it is distinct from its members or founders. It can own property, incur debts, raise capital, enter & execute contracts. The liability of members is limited to the amount contributed to the company as share. A change in membership doesn’t affect the existence of the company. The regulatory and administrative controls and formalities are more complex than other business structures.

Conclusion

We see that a range of diverse factors, conditions and situations decide the final choice of a business structure. If a business owner chooses to limit his liabilities, then Proprietorships & partnerships will be avoided and instead Limited Liability partnership or company shall be preferred as they offer limited liability. This assessment of liabilities, in turn, shall rest on the nature of business, type of market, size of business and capital investment required and other factors such as chances of litigation and lawsuits concerning the type of venture. For a business having high volumes, high debt, the large scale of operation, fluctuating markets business structure having limited liability will be preferred. Considering the taxation part, if the owner wants to ease his tax burden, he will prefer proprietorship wherein he has to declare only his personal income, and no tax on profits or dividend is applicable. If the type and scale of business require huge investments, then a company is preferable as generally investors prefer the same. Moreover, the owner has to consider the amount of control he wants to have in the business. For a greater administrative and financial control, he may opt for a proprietorship. Also, the workforce in an organisation plays an important role in its sustenance & success. In a company business structure, it is easier to incentivize employees by handing over equity.

We can conclude that decision to choose a particular business is very critical to the future goals of the business and paves a path for its further survival and performance. This decision is complicated and has to be dealt with considering the right balance of various factors defining and affecting the business.